Beware of the tax man
The Chancellor has delighted many people in giving greater flexibility in when and how to take their pension savings, even allowing all of it to be taken in cash. Tempting as it is to take the money, beware the sting in the tail
The Chancellor has delighted many people in giving greater flexibility in when and how to take their pension savings, even allowing all of it to be taken in cash. Tempting as it is to take the money, beware the sting in the tail.
Update – October 2024 Autumn Budget:
In the Budget of 30 October 2024, the government announced that pension savings will be considered part of someone’s estate and liable to inheritance tax (IHT) from April 2027. This will be within existing IHT rules: IHT is not payable by a person’s spouse or civil partner, and is only typically payable on estates over relevant IHT thresholds.
Another aspect of inherited pensions is income tax. Currently, if you pass away before age 75, any pension funds or annuity income your beneficiaries receive is free of income tax, whereas they are liable for income tax at their marginal rate if you die after age 75. Retirement Line’s understanding is that this will remain unchanged.
There was a consultation period after the Autumn Budget, followed by a government update on its plans for IHT on pensions. Please see our September 2025 report on this update: Government publishes more details of reforms of inheritance tax on pensions. We will continue to monitor and report on this issue as further information becomes available.
While you can normally take 25% tax free, remember the rest is treated as income and is subject to income tax at your marginal rate, potentially at 40% or 45%.
Be careful of being landed with a big tax bill
When you are at work you get used to simply paying the basic rate of tax through your employer, so you might not realise dipping too freely into your pension fund at retirement may put you into the higher-rate tax bracket. You might not have had to file a tax return before, but taking additional money from your pension could mean you have to start completing self-assessment forms or risk being fined by HMRC. You may be liable for a £300 fine from the taxman if you take extra money from your pension and then fail to inform all other pension firms holding your retirement savings within 91 days.
Considering buy-to-let?
You may be tempted to use your retirement savings to acquire a buy-to-let property or another type of investment, but be careful to weigh up the tax implications carefully first, because tax paid out upfront to HMRC could prove a significant drag on returns. Please note that taking money out of a pension will generally result in paying income tax. If you then invest that money, you could end up paying tax again on the new investment.
It might also be sensible to avoid drastic decisions before the May election, which could bring in a new government that immediately starts tinkering with pension reforms and the tax system.
Example tax calculation
MGM has compiled the following example showing how someone who has a £20,000 pension pot might fall into the trap of paying too much tax after April 2015.
* An individual earns £33,288 a year, which is the average income for someone about to retire according to official statistics.
* They have a pension fund worth £20,000 and decide to take all of it at retirement under the new rules.
* The first 25 per cent, or £5,000, is tax free and the remaining £15,000 is taxed as income.
* Earnings of £33,288 plus the £15,000 taxable portion of the pension money make a total income of £48,288.
* This pushes the individual over the higher-rate tax threshold of £42,385.
* The tax payable on the £15,000 pension payment would be £4,180.60, or an effective tax rate of 27.87 per cent.
On the plus side!
The Chancellor has improved the death benefits of both annuities and drawdown, which may enable you to pass your pension fund on to your loved ones tax free:
With a joint-life annuity, if you die before age 75, the income you leave to your named dependants will be tax free for them for the rest of their life.
With drawdown, again if you die before age 75, any pension fund remaining can be passed on tax free to whoever you choose, either as an income or lump sum. They then have the ability to set up their own drawdown account and, on their death, can pass the remaining fund on too, perhaps to the next generation.
Even if you die after age 75, the current 55% tax on lump-sum death benefits will reduce to 45% in the tax year 2015/2016, then be at the recipient’s marginal rate in future tax years.
Please note, Retirement Line are not tax specialists, so if you are in any doubt about the tax implications of taking your pension fund, you should seek advice from an accountant.
Which option is for you?
We appreciate that choosing the correct route can be daunting, so we would be delighted to assist you with explaining the various retirement income options. If you have any questions, please do not hesitate to contact us on 0800 652 1316.
